On July 15th 2015, the Administrative Court took a decision on the application of the concept of the abuse of law to transactions performed by a Luxembourg taxpayer.
In the case at hand, a Luxembourg company (the “Company”) entered into an advisory agreement with a company located in the British Virgin Islands (the “BVI Company”) according to which the BVI Company was assisting the Company in the development of consumer financing and insurance activities through one of its indirect subsidiaries. Due to the financial crisis, this activity was eventually not successful for the Company. The tax administration rejected the deductibility of the fees paid by the Company to the BVI Company under the advisory agreement, requalified them as a hidden dividend distribution and considered that these transactions were constitutive of an abuse of law according to §6 of the Adaptation Law (Steueranpassungsgesetz).
The Court reiterated the well-established four cumulative criteria used to qualify a specific case as an abuse of law:
- the use of forms and institutions of private law,
- a reduction of tax,
- the use of an inappropriate ”path”;
- the absence of non-tax reasons justifying the use of the chosen ”path”.
The Court took the position that, in the matter of abuse of law, the burden of proof is split between the tax administration and the taxpayer. The Company having provided the contracts, a structure chart and explanations in order to justify the economic reality of the transaction, the tax authorities should have provided concrete points supporting the argument against the economic reality of the transaction. The fact that the BVI Company is not subject to an effective taxation and is domiciled in a country (the BVI) where there is no double tax treaty providing for the automatic exchange of information is not sufficient to conclude that the BVI company is a shelf company and the payments made to the BVI Company are constitutive of an abuse of law.
In addition, the Court concluded that the tax authorities did not demonstrate that the legal structure was set up solely for tax purposes which is an essential requirement to qualify a legal construction as an abuse of law and in the case at hand it was prima facie in the economic interest of the Company and the BVI Company to have the services described in the advisory agreement becoming successful.